David R. Henderson  

Arnold Kling's Paradox of Thrift

Today on the Eurozone Crisis... The Hack...

On my list of potential topics to blog about in the last few days was Megan McArdle's excellent post in which she advises people to save more. I've gone after her here, here, and here and so I like to balance things because she really is a very sharp, informed, analytic blogger.

I didn't get around to it, but having read Arnold's critical post on hers this morning, I need to.

Yes, Arnold is right that if saving doesn't lead to more capital formation, then one person's saving is another person's dissaving. (Arnold's claim that it's zero sum doesn't follow, by the way, because, as commenter Fralupo pointed out, people gain from trade and in this case they are trading on different discount rates.)

Commenter Bob Murphy implicitly points out the problem: the assumption that an increase in saving nationwide would not lead to an increase in capital formation is highly implausible. This is, essentially, a Klingian paradox of thrift.

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COMMENTS (4 to date)
Tom West writes:

I think people are taking Arnold's post a little too literally. It was essentially just a grump that (1) people are going further and further into debt to finance consumption without any real idea/means of paying it back and (2) the government is basically going to steal anything of value (including your savings) anyway.

Perhaps he was having a particularly discouraging day.

Bryan Willman writes:

First, "squander" depends on circumstance. In particular, if I die the 1st of Jan 2013, all of the money (and other resources) I DON'T use up in consumption between now and then is in a very real way "squandered".

Second, to the extent that increased net savings get used up financing deficit spending on current consumption output, then they are not really maintaining or increasing future capital. So they create a claim on the production of the future economy, without growing that future economy. (Various folks have raised various versions of this complaint.)

That's the real issue - Megan herself warns that "tax now tax free later" retirement schemes are vulnerable to government breaking its promise and taxing them later. So any long term savings is always at risk of being worthless or nearly worthless due to calamity. Today's consumption has no such risk.

By all means people should save and invest, in sensible ways. But it's not "save" versus "squander".

Vadim writes:

It's not a paradox at all. Just imagine if nationwide savings is then invested in, say, a massive housing bubble. Potentially trillions of dollars of savings lost, wasted, through malinvestment.

fundamentalist writes:

Part of the solution to untangling the paradox is asking what do people spend the borrowed money on? If they spend it on living beyond their means, as governments do, then it's not zero sum; everyone grows poorer.

But if the borrowed money gets invested in expanding enterprise, then everyone grows richer.

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